Private equity

Many investors turn to publicly traded stocks as a source of growth and diversification. Public companies, however, represent less than 1% of all U.S. companies. The other 99% are privately held,1 and historically only accessible to large institutional investors. Investing in the equity of private U.S. middle market companies may provide an alternative source of income, growth and diversification.

The private U.S. middle market

The U.S. middle market is comprised of nearly 200,000 businesses and accounts for more than 47 million jobs.2 Collectively, U.S. middle market companies account for one-third of all jobs and 33% of private GDP and generate over $10 trillion in annual revenue. If ranked as a country, the U.S. middle market would rank as the third-largest global economy.2

Long-term performance

Private equity may provide investors with an alternative source of growth for their portfolios. As shown below, private equity has meaningfully outperformed the S&P 500.3 Higher returns may be accompanied by increased risk and, like any investment, the possibility of an investment loss. Investing in alternative assets, such as private equity, relies less on publicly available data and more on a manager’s ability to analyze and underwrite its investments.

Individual vs. institutional access

Many leading endowments, public pension systems and sovereign wealth funds have historically allocated a significant portion of their portfolios to private equity through private equity funds. In recent years these institutions have increased their private equity holdings, as a percentage of total assets under management, to a weighted average of 12% of total assets under management in 2014 from a weighted average of 6% in 2006. For example, Yale Investment Office (33% allocation), the California Public Employees Retirement System (11% allocation) and the Canada Pension Plan Investment Board (19% allocation) have all significantly increased their respective allocations to private equity in recent years.4

Private equity is typically associated with institutional investors due to the high investment minimums and suitability requirements of most private equity funds. Historically, individual investors’ portfolios have little, if any, direct exposure to private equity. Individual investors and endowments may have different investment horizons, liquidity needs and risk tolerances.

Investor considerations

Investing in private equity is different than investing in traditional investments, such as stocks and bonds. The equity securities of private companies are often illiquid and issued by below-investment-grade companies. When building a portfolio that includes private equity, investors and their financial advisors should first consider the individual’s financial objectives. Investment constraints such as risk tolerance, liquidity needs and investment time horizon should be taken into consideration.

1 The National Bureau of Economic Research, http://www.nber.org/digest/apr07/w12354.html.

2 National Center for the Middle Market, 4Q 2016 Middle Market Indicator, http://www.middlemarketcenter.org/performance-data-on-the-middle-market. The Middle Market Indicator is a quarterly business performance update and economic outlook survey conducted among 1,000 C-suite executives of middle market companies. For purposes of the 4Q 2016 Middle Market Indicator, the National Center for the Middle Market defined the middle market as U.S. companies having annual revenues from $10 million to $1 billion.

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